Micro-units can lead to macro-returns for investors

Millennials and white collar executives are flocking to major cities, which come with a high price tag. So, how can people in mid-range income brackets afford to live in primary gateway cities such as New York City, San Francisco, and Philadelphia? Micro-units are making the unattainable more feasible for entry-level workers looking for affordable housing in major downtown markets and commercial real estate investors have taken notice.

These efficiency apartments, generally under 400 s/f, are a wise investment for developers, investors, and tenants. As any city-dweller can tell you, the high cost of living in urban markets plays a role in the decision-making process for prospective tenants and developers. It is extremely expensive to acquire land in major cities, and construction costs continue to skyrocket. These factors, along with ongoing redevelopment and the rise in demand, has led to lower yields on investments. Developers are now renovating two-bedroom apartments into three-bedroom apartments to increase their returns. Rents for tenants in these small spaces are within the means of young executives willing to choose an ideal location over square footage. This trend isn’t likely to slow down, as the scarcity of developable sites diminish and construction costs remain high. Rents in urban areas will only increase, along with interest from millennials. All arrows point to consistency for this type of asset.

Meanwhile, micro-units are growing beyond gateway cities. The concept is seeing an upswing in secondary markets like Kansas City, Pittsburgh, and Houston. There is less institutional capital available in these downtown areas and more competitive loan to value. This allows investors, wary of gateway cities, to establish a presence in emerging asset classes, and diversify their experience.

Micro-units are an important find for investors exploring new asset capabilities and identifying growing markets. The value of such apartments within the commercial real estate sector lies in their ability to meet the needs of millennials looking for housing they can afford, in often unaffordable areas.

Daniel M. Palmier is President and CEO of UC Funds, a provider of debt and equity capital solutions. 

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